Beige Book Report: Cleveland

October 24, 2018

Summary of Economic Activity
Business activity in the Fourth District grew modestly during the survey period and firms reported customer demand was stable. Reports suggest that hiring continued at about the same moderate pace as in recent months. Contacts reported ongoing shortages of both the quantity and quality of available labor and firms increased wages modestly to reduce worker turnover. Upward pressure on input costs was strong, notably for metals, construction materials, and fuel. Final selling prices increased as manufacturers, builders, and transportation firms raised their prices to cover their increased input costs. Manufacturing capacity utilization rose to keep up with strong demand. Freight demand plateaued at a high level and firms are increasingly feeling the pinch from limited trucking capacity. Retail demand, excluding autos, was flat. Nonresidential construction activity picked back up after a lull during the prior period.

Employment and Wages
District employers reported hiring activity that was broad-based across sectors and momentum that was similar to that in recent survey periods. Contacts generally reported business conditions that were favorable and stable as supporting their overall demand for workers. However, worker shortages, in terms of both quantity and quality, were noted across many sectors. One retailer remarked that the firm's headcount was unintentionally lower because it was losing warehouse workers faster than it can replace them. One trucking contact reported that it had 10 empty trucks because of its inability to find enough drivers with Class A commercial driver's licenses. Some manufacturers reported increases in overtime hours worked. In addition to limited labor supply, contacts noted that overall gains in staff levels were limited by high worker turnover.

Overall wage trends were comparable to those of recent survey periods, with many contacts reporting wage increases that were slightly above the rate of inflation. In every industry, contacts noted that increased competition was requiring their firms to boost wages to retain workers. Yet a number of contacts speculated the raises were not likely sufficient to stem worker turnover. There were a few cases in which wage increases were much stronger than average. One retailer gave a 9 percent raise to new and current staff in the hope that the higher wage will reduce turnover. One construction contact reported taking a more targeted approach by giving 10 percent to 15 percent raises on a case-by-case basis; firm-wide, wages were raised by only about 2 percent. In professional services, contacts reported using bonuses and non-wage components to increase compensation.

Prices
Upward pressure on nonlabor input prices was strong, although prices rose for slightly fewer contacts than in the last report. Construction contacts reported increases in prices for LED lighting, concrete, steel, lumber, and copper. The majority of contacts attributed at least some of these increases to import tariffs. One trucking contact noted that prices for pallet jacks, tires, and packaging material were higher because of the tariffs. Only one construction contact noted that the diversion of materials for hurricane relief may have had an additional impact on prices. A few contacts remarked that the amount of time suppliers held their prices constant had diminished noticeably. In other sectors, higher fuel costs were reported.

Final selling prices rose with about the same momentum as in the prior period. Freight and construction firms were less aggressive in raising their prices than in the previous survey period. Construction contacts commented that they were raising their prices enough to maintain their margins. By contrast, one builder remarked his firm was holding prices and offering more incentives and giveaways. Nearly two-thirds of manufacturing contacts raised their prices this period. This was the fifth consecutive reporting period wherein more than half of manufacturing contacts reported raising their prices. Service-sector industries reported relatively more modest price increases as firms attempted to cover rising worker compensation costs.

Consumer Spending
Retail demand was flat during this period, breaking a nearly year-long trend of improving demand. Expectations for the near-term were mixed: retailers of nondurable goods expect demand to pick back up in advance of the holiday season, but auto retailers expect demand to remain flat. Auto retailers noted that new vehicle sales have declined slightly because of rising interest rates and increased unit prices. As a result, buyers have shifted somewhat toward used vehicles. Retailers with broad footprints noted that sales within the Fourth District were roughly in line with national retail sales. Retail profit margins were generally unchanged and inventory levels were reported to be good.

Manufacturing
Manufacturing demand remained strong, and contacts cited strong economic fundamentals as the cause. Industrial equipment manufacturers reported strong demand from the automotive, agriculture, and construction equipment industries. Some steel and heavy equipment manufacturers noted that demand was down slightly compared with demand two months earlier, but it was particularly strong in the early summer months as customers sped up purchases ahead of anticipated price increases. Several contacts reported increased capacity utilization to keep up with strong demand, while long lead times and tariff-related gaps in supply chains have caused mismatches in inventories. Contacts reported that they have increased their capital expenditures to keep up with customer demand and to fill supply chain gaps left by suppliers' capacity constraints.

Real Estate and Construction
Homebuilders reported that demand fell modestly, but they do not expect demand to fall further in the near future. Homebuilders point to a decrease in home affordability as the primary driver of this demand decrease. Lower-priced homes are selling better than more expensive homes. Builders are reducing the number of spec homes they are building. Real estate contacts reported an increase in homeowners relative to renters. These contacts also reported stable housing inventory and consistent demand from first-time homebuyers.

Nonresidential builders reported a pickup in demand after a lull during the prior period. Demand growth was driven by private spending; demand from the public side was still low. Builders note that backlogs are still high and pointing to strength in the broader economy, and they expect growth to continue in the near term. Nonresidential construction prices are rising as builders pass through increasing materials costs, especially for metals, but builders are not increasing their margins.

Financial Services
Bankers reported that overall conditions held steady during the last two months. Some contacts reported that demand for commercial and industrial loans softened as businesses shifted to cash earned in the strong economy while another noted increased activity in commercial real estate and in mergers and acquisitions. Mortgage demand and core deposits were a bit stronger than the previous survey period, but contacts noted that this strengthening may be a seasonal trend. Delinquency rates remained low; one contact reported that the delinquency rate was at a record low, suggesting that financial conditions are strong.

Nonfinancial Services
Nonfinancial services firms reported stronger demand as the macro economy continued its ascent. Business advisory and IT firms attributed the favorable business conditions to their clients enjoying tax savings, higher revenues, strong business confidence, and increased budgets for digital transformation. Contacts reported that plans for capital investments held steady. In the transportation sector, demand plateaued at a high level. Contacts reported that limited freight capacity continues to hamstring growth in the industry. One trucking contact noticed growing discontent among members along the food supply chain, from grain producers all the way to restaurants, about the limited availability of trucks to transport their goods. This contact also noted that these firms were all planning to pass rising transportation costs through to their customers in a variety of ways.